What Happens If a Brokerage Goes Out of Business?

When a brokerage firm ceases operations, investors naturally become concerned about the safety of their assets. Mechanisms are in place to help protect client holdings if a firm goes out of business. This article explains these safeguards and outlines the process that unfolds during a brokerage firm’s failure.

Protections for Investors

The primary protection for investors is provided by the Securities Investor Protection Corporation (SIPC). This non-profit corporation was established by Congress under the Securities Investor Protection Act. Its purpose is to protect customers of SIPC-member brokerage firms that become insolvent.

SIPC protection covers customer securities and cash up to $500,000, including a $250,000 limit for cash claims. This coverage applies per customer, per brokerage firm, and is based on different “separate capacities” or account types. For instance, an individual account, a joint account, and a Traditional IRA at the same firm are each considered separate capacities, potentially allowing for greater overall coverage.

SIPC protection safeguards against the loss of securities and cash due to the brokerage firm’s failure, not against losses from market fluctuations or poor investment performance. This differs from the Federal Deposit Insurance Corporation (FDIC), which insures bank deposits up to $250,000 per depositor, per insured bank. While FDIC covers cash held in bank accounts, SIPC covers assets held in brokerage accounts. Most brokerage firms that conduct business with the public are required to be SIPC members.

The Process of Brokerage Failure and Recovery

When a brokerage firm faces financial distress, the Securities Investor Protection Corporation (SIPC) typically initiates a liquidation process. This process often begins when a securities regulator, such as the Securities and Exchange Commission (SEC) or the Financial Industry Regulatory Authority (FINRA), refers the failing firm to SIPC. A federal court then usually appoints a trustee to oversee the liquidation.

The trustee’s responsibilities include taking control of the firm’s books and records, which can sometimes be a lengthy process if records are disorganized. A primary goal of the trustee is to return customer property, meaning their securities and cash, as quickly as possible. If the firm’s records are accurate, the trustee, under SIPC’s oversight, may arrange for customer accounts to be transferred to another brokerage firm. Customers whose accounts are transferred are promptly notified.

If accounts cannot be directly transferred, or if there are missing assets, a claims process begins. The trustee gathers customer names and addresses and, once court-approved, sends out claim forms to customers. Customers must file a claim within a set timeframe, as failing to do so can result in the loss of their claim. SIPC funds are then used to satisfy valid claims up to the specified limits, ensuring customers receive their covered assets or their market value.

What is Not Covered by Protection

While SIPC provides a valuable safety net, it does not cover all types of losses or investments. It does not extend to investments that are not considered “securities” under the Securities Investor Protection Act. Examples of assets typically excluded from SIPC coverage include commodity futures contracts, foreign exchange (forex) trades, and certain fixed annuities or investment contracts not registered with the SEC.

SIPC does not protect against losses from fraudulent schemes, such as Ponzi schemes, unless the fraud directly results in the brokerage firm’s insolvency and missing customer assets. It also does not cover losses due to a broker’s bad investment advice, unauthorized trading, or other forms of investment fraud. For such issues, investors generally need to pursue other legal avenues or report to regulatory bodies like FINRA or the SEC.

Steps Investors Can Take

To enhance the safety of their investments, individuals can take several measures. Before opening an account, verify that a brokerage firm is a member of SIPC, which can be confirmed on the SIPC website or by checking the firm’s disclosures. Investors should also use FINRA BrokerCheck to research the firm and any associated financial professionals, reviewing their employment history, licenses, and any disciplinary actions. This free tool provides transparency into the professional background of those handling your investments.

Maintaining diligent record-keeping is another important step. Regularly reviewing account statements and trade confirmations is essential to ensure accuracy and to promptly identify any discrepancies. If an error or unauthorized activity is discovered, investors should immediately notify the brokerage firm in writing, as this can be crucial for future claims.

If a brokerage firm faces financial trouble or goes out of business, investors should stay informed by monitoring announcements from the firm, regulators, or the SIPC. If a trustee is appointed, they will provide instructions on how to proceed, including how to file a claim. Even if an account is transferred to another firm, it is advisable to still file a claim with the trustee to ensure all assets are accounted for. Prompt action and providing all requested documentation are important to facilitate the recovery process.